THE HEDGEYE EDGE
Avalara (AVLR) isn’t such a young company, originally founded in 1999, and then in its current form in 2004.
At its core, AVLR is still a growth company. But they may not be a tech company. Consider: The various parts of their engine were nearly all built via acquisition and the company (allegedly) re-architected much of their product after meeting a tiny competitor who is now suing them for appropriating his architecture despite having an NDA with the company.
Then you stack additional items, such as:
- Disaffected sales force
- A ‘sales-oriented’ company
- A litany of problems inside the corporate culture
- Revolving door when it comes to technology leadership roles
- A large platform reseller sitting on its best market opportunity
- A large software vendor totally deflating the value proposition at the mid-low end of the market
- States not necessarily able to enforce compliance (today) and mostly tolerate best effort
The recent lawsuit points to an innovation problem inside the company; the M&A path points to the same problem as most of the key functionality of the software has been acquired over time.
The lack of addressable market is real in many ways: AVLR is selling an expensive version of something that is available at cheaper price points with better pricing transparency, and into a market that has a mixed opportunity set of open and closed doors.
Furthermore, the employee disaffection is real and makes us think the December lock-up expiration will be met with jubilatory selling. Employees had been promised an exit for several years prior to the IPO (including a full IPO prep in 2015). Based on our reviews of employee comments, we expect a fair bit of pent up selling.
INTERMEDIATE TERM (TREND)
AVLR will have points of acceleration from some increments of large enterprise customers, at a much higher per company ARPU than the mid-tier (but also a much longer sales cycle).
The company is also benefiting from the sales re-org in mid-2017, which should help y/y recurring revenue capture for the next 3 quarters in addition to the recently announced 3Q18 results. We noticed slowing Sales & Marketing headcount adds recently, which should have been a sign that incremental efficiencies were on the horizon, and AVLR proved it in 3Q18 with ~$2MM of incremental OPEX against $6MM of incremental revenue. The combination of faster topline growth and slower OPEX growth will begin the process of healing what has been, up to now, a wildly inefficient model.
The recent 3Q18 acceleration was 100% circumscribed within the range of our understanding as both the y/y comping of the sales re-org + some interesting M&A that closed in May (which wasn't so small on a transactions basis) seemed to be key contributors. But the boost is not about a better solution incrementally opening up an accelerating market opportunity. It is a comps issue which then reverses in 2H19 and poof you have a long term sub-20% grower.
To maintain over 20% growth by then will require some chunkier M&A. So, if there isn't that much downside from here, we shrug, and also say, we aren't believers in the upside either. Our advice would be, short the pops.
LONG TERM (TAIL)
We aren’t willing to give this a premium by any stretch. Mid-20%s growth rate in the next few quarters will sunset by mid-2019 on a comps basis and sag to below 20% growth. A middle of the road EV/2019 revenue multiple of ~6x gets us sub $30 per share, basically around our original price target when we put the Short on at $44. You would have to use some pretty aggressive FCF multiples just to get to our current price target, so there is no salvation from that corner. We see downside to mid-$20s levels.